America's Fiscal Dead End: A 2013 "Minsky Moment"

Often times we are amazed that Deutsche Bank's Peter Hooper works in the same place as that other "economist." The reason is that yesterday, Hooper, who tends to have some of the most original sellside thoughts, came out with one of the best summaries of America's fiscal dead end:an 8 page summary far more accurate and detailed than anything to ever come out of the rating agencies, yet one which reaches the correct conclusion. What is startling is that a Wall Street institution (well technically desk.... there is of course that other "economist") is willing to come to grips with the truth. Which according to Hooper is rather ugly: America may have 2 years at the most before it all comes crashing down when the world's former superpower hits its own Minsky Moment.

Hooper's summation:

A 2013 solution? A bigger risk is that after having raised expectations that more fundamental progress can be made in dealing with the unsustainable US fiscal position, the political process breaks down and no meaningful progress is made even with the debt ceiling and default avoided. Certainly it will be difficult for any elected politician to be too specific about major cuts in entitlement benefits or increases in taxes ahead of the next election. The Obama Administration is likely to resist measures that could add significantly more fiscal drag than is already in the pipeline for 2012. Scuttling the still fragile recovery could be political suicide. In any event, it would make sense to have fundamental decisions about the size and redistributive nature of the US government made after a full airing of this debate in the next Presidential election. If the ratings agencies and the market give the US government the benefit of the doubt for a time, given that the debate has begun and recognizing that any longer-term resolution will be difficult in an election season, a better opportunity for resolution may come in 2013. Conventional wisdom holds that if the economic recovery progresses as expected, President Obama will be re-elected. At the same time, assuming the Ryan plan does not backfire, the political winds may favor a Republican takeover of the Senate, given that nearly twice as many Democrats in the Senate are up for reelection as Republicans, and only a three-vote swing is needed. A Democratic President dealing with a Republican Congress and a popular mandate to resolve the fiscal problem would be a repeat of the conditions that led to the last major fiscal reform move with President Clinton in the early-mid 1990s. And Obama would have the added advantage of being a second term president. This mix would necessitate a political compromise in a case where compromise will clearly be needed to achieve a lasting resolution. However, there are no guarantees that such a scenario would materialize, and even if it did, deep-seated political differences on taxes and spending could still prevent a resolution of the problem in 2013. In this case, markets could very well balk, leading to a US Minsky moment, with potentially far greater consequences than the one Europe has experienced.